Working Paper: NBER ID: w22695
Authors: Matthew Baron; Wei Xiong
Abstract: By analyzing 20 developed countries over 1920–2012, we find the following evidence of overoptimism and neglect of crash risk by bank equity investors during credit expansions: 1) bank credit expansion predicts increased bank equity crash risk, but despite the elevated crash risk, also predicts lower mean bank equity returns in subsequent one to three years; 2) conditional on bank credit expansion of a country exceeding a 95th percentile threshold, the predicted excess return for the bank equity index in subsequent three years is -37.3%; and 3) bank credit expansion is distinct from equity market sentiment captured by dividend yield and yet dividend yield and credit expansion interact with each other to make credit expansion a particularly strong predictor of lower bank equity returns when dividend yield is low.
Keywords: credit expansion; bank equity; financial crises; equity returns
JEL Codes: E02; E03; G01; G02
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| credit expansion (E51) | increased likelihood of bank equity crashes (F65) |
| credit expansion (E51) | lower expected mean excess returns for bank equity index (G12) |
| large credit expansions (exceeding the 95th percentile) (E51) | substantially negative mean excess return (G12) |
| credit expansion + dividend yield (G35) | predictability of bank equity returns (G17) |